Zeev, I find your logic on a rate increase to be very sound. I might add that it would probably shake money out of the bond funds which have been being pitched fairly heavily these last few months. There are too many looking for another rate cut to spike bond fund prices up even higher...
You may hope the Fed raises but accrding to the minutes of their last meeting, they are closeer to easing
besides, do you really want them to raise? no matter how good their (or your) arguments are, do you really wanna hear that dude on this thread who drones on constantly about Greenspan??
Don't think I understand these things, but it does seem that a FED tightening might make more sense here. At least if we can conclude that deflation is more of a problem than the inflation in commodities which it can be argued is due mostly to the temporary problems regarding the weather and war.
All of which suggests interest rates are more likely to increase than decrease.
Big Picture: Annual wholesale prices reached a half century low in May led by the drop in energy prices and the weak global economy. The annual core deflation is the strongest in at least 25 years. Deflation throughout the wholesale stages (raw through finished goods) argues against the risk of an upturn in consumer price pressures over the intermediate term. The drop has been dramatic as May's half century low of -2.7% contrasts with January 2001's decade high of 4.7%. The core (ex-food and energy) fell in to annual deflation in July from near 2% in early 2001. The only inflation concern comes from the stickier service prices (medicine, education, housing) seen in consumer prices. The need to guard against the risk of deflation is now the hot topic at the Fed.
As a temporary measure, monetary policy could be effective even in a liquidity trap if the central bank were to undertake open-market operations in assets other than short-term government debt. By increasing the demand for, say, long-term Japanese government bonds the Bank of Japan could surely have a positive impact on the economy even now. But while such measures would probably have a substantial short-run impact, they would only be effective in the longer term if the central bank were actually to acquire a substantial share of the relevant assets outstanding - which would raise some uncomfortable questions about the nature of the central bank's role. The obvious answer to sustained deflationary pressures, then, is the now-notorious proposal for "managed inflation": since deflation is the result of an economy "trying" to get the expected inflation it needs, to avoid deflation one must provide that expected inflation by credibly promising that future price levels will be sufficiently high compared with the present. And this is where I get nervous. This nervousness is not because the idea of fighting deflation by promising inflation is crazy: it is in fact a straightforward conclusion from quite standard models. Indeed, once one admits that deflationary pressures come from the persistence of a savings-investment gap even at a zero interest rate, it is hard to see how this conclusion can be avoided. But the idea sounds crazy, and that is a problem. How can we get finance ministers and central bankers, who have spent their whole careers preaching the evils of inflation and the virtues of price stability, to accept the idea that price stability may not be an available option? For if deflationary forces are as powerful as they are in Japan - and may soon be in the rest of the world, if The Economist is right - there is no middle ground. Either policy gives the economy the inflation expectations it needs, or the economy will try to get that inflation via grinding deflation - a proposition that sounds paradoxical but is actually a matter of simple economic logic. Attempts to find a halfway house - to aim merely for stable prices rather than sufficiently high inflation - will be doomed to failure.
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